Why hasn't the Canadian real estate market collapsed yet?

Chart of the Week | 08/11/2017

Kassandra Canada?

After the inflation rate approached the ECB's target of “below, but close to two percent” in baby steps in the first few months of the year, calls were expected from Germany that the European Central Bank was finally starting to exit its low interest rate policy must initiate. In the self-understood “land of savers”, one would like to see significant interest on their bank balances again. But an old wisdom could also apply here: "Be careful what you want - you could get it".

Right now Canada knows a thing or two about it. Central banks had reduced their key interest rates not only in the euro zone, but around the world in order to contain the consequences of the financial crisis and to support the economic recovery. Despite its proximity to the USA, the origin of the international financial crisis, the Canadian economy largely managed to avoid a slump. In particular, the real estate market, which had started the crisis in the USA and almost completely collapsed, was in excellent health north of the border - prices simply continued to rise. While real estate prices in the US are only around 13 percent above the 2007 level, they have risen by around double in Canada, as our chart of the week shows. The reasons for the real estate boom are low interest rates, the booming economy, increasing employment and international investors. Factors that are not entirely unknown to us in Germany either. As house prices rose, so did the debt of Canadian households - partly because larger amounts of credit had to be taken out to buy a house or apartment, partly because real estate owners saw their wealth rise along with the prices of their property and had few concerns about consumer wishes via Finance credit. In the meantime, price developments have also decoupled from income developments. Housing in metropolitan areas has become almost unaffordable for many people in the so-called middle class.

In July, Canada's central bank made the first rate hike in seven years, raising the rate from 0.5 to 0.75 percent to prevent rising inflation and possible overheating of the real estate market. In view of the robust economic development, this is actually a justifiable step. In addition, the Ontario government passed a "Fair Housing Plan", which is intended to put a stop to foreign speculators in particular. That combination shocked the housing market. Ontario's provincial capital, Toronto, Canada's largest metropolitan area, saw residential property sales plummet 40 percent from June. After prices had already fallen a little in the previous months and announced a possible end to the price fireworks, in July they were a whopping 19 percent below those of April 2017, the most expensive month in history to date.

Catastrophe warnings are likely to be exaggerated because the price correction is still at a high level: the prices in July were also still five percent higher than in the same month last year. But a weakening of the boom, especially in view of the high household debt, could be fatal for the consumer climate.

Even if there is still no reason to panic, the Canadian real estate market is definitely a good warning. Many factors that led to the boom in Canada also exist in Germany. The biggest difference at the moment is that the level of consumer debt has not changed - the greatest security against the risk of a bursting bubble. Canada is currently showing Europe that not only should the ECB exercise the greatest caution in normalizing its interest rate policy, but also that corrections in the real estate market can also occur in healthy and booming economies.

 

Housing is also expensive in major German cities